Whether it’s your dad, mom, or your crazy uncle Mike (because everyone has an uncle Mike), there is always that one person who really advocates strongly for you to invest your money right this second because it’s worth more now than it will ever be in the future. To be fair, whoever that person is for you, they’re not necessarily wrong.
What really is the time value of money?
What will $100 today look like in 5, 10, 40 years? While no one is really sure what the inflation rate will be at any of those points down the line, what we all like to look at is what has happened in the past, classic finance analytics.
The U.S. Bureau of Labor Statistics shows that the U.S. has averaged a 3.28% inflation rate from 1914-2017 with an all time high of 23.70% in June of 1920, and a record low of -15.80% in June of 1921.
The roarin’ 20’s am I right?
Okay, great, I still have the $100... how’s it going to change? Well, if we want to keep it simple we can apply a basic calculation to figure out what something that costs $100 now will cost in, let’s say, 10 years.
If you do the math and carry the 1 that number comes out to $138.09.
(the real calculation is pv=100, n=10, I/Y=3.28, cpt fv =138.09 on my trusted BA-II plus)
Alright, so I’m saving myself $38.09? Uncle Mike, I’ve seen you spend that in a second: 4 packs of Marlboro lights and a Natty tall boy. So why are you telling me that this is such a big deal?
It’s not necessarily just the inflation that is factored into the time value of money. The whole idea of time value of money is that money available at the present time is worth more than the same amount in the future due to its potential earning capacity (source: Investopedia, Dictionary.com, and yes, your Uncle Mike). Yes, you may need to read that last sentence again before we can continue so this article is worth your time.
Potential Earning Capacity
*hint I’m an Investment Advisor, you can bet where we are going next.
The real purpose of an investment is to pace and ultimately beat inflation. What is that variable that really gives your investments the necessary boost that you want to see? No, it’s not Apple, Alphabet, or Dynavax; it’s time. And time is something that your uncle Mike has on you. Chances are he’s seen what time can do for money and is advising you to be a part of it. Still skeptical?
Here’s a super simple example. John’s 25. He’s going to invest $10,000 but he’s not sure if he wants to do it until he’s 30 or 35. Let’s say John is using this money for retirement and wants to retire at 65. John just wants to put this $10,000 in and then never touch it again until 65. Let’s see where he ends up if we give him a conservative 6% annual return over that period. (not factoring compounding, just basic calculation for educational purposes)
John at 25 puts in $10,000, the value at 65 is $102,875
John waits until age 30, puts in $10,000, the value at 65 is $76,860
John waits until age 35, puts in $13,809 because he thinks he’s smart and accounts for the inflation over that 10 year period, the value at 65 is $79,311
This is the point that the knowledgeable-yet-maybe-crazy person in your life is trying to make. John missed out on $20-25 thousand by waiting just 5 or 10 years. Long story short, listen to your Uncle Mike.
financial advisor, economics junkie, sports fanatic
"Money is tough; it's something that we all use on a daily basis, yet it doesn’t ever come with instructions. If you have questions, reach out to me or someone else at Fischer Wealth Management so we can help you achieve what matters."